Would EU bonus cap spark banker flight?

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Pay packages for City bankers probably won't take a hit, but compensation will be shifted away from bonuses, says Rundle.

Story highlights

The EU announced it will cap bankers' bonuses at a year's salary, or possibly two years'

This agreement needs to be formally approved by ministers and would impact the City of London

Officials are attempting to turn the page on the sovereign crisis the EU, writes Rundle

Another day, another blow for Britain's financial sector -- and this time it's not the stench of brazen traders rigging rates or banks misspelling insurance products.

The latest setback for London's banking sector -- the largest in Europe -- comes in the form of the EU's announcement it will cap bankers' bonuses at a year's salary, or two years' if there is explicit approval from shareholders.

Now that may cheer up the general public, who have long expressed outrage at the hefty bonuses bankers have earned and continued to amidst scandal, economic deterioration and government bailouts -- but it's certainly not music to the ears of British Prime Minister David Cameron.

The EU hammered out this agreement, which still needs to be formally approved by ministers, during intense negotiations, despite the fact Britain has vocally opposed any cap on bonuses.

The UK government has long argued that cutting bankers' bonuses would prompt an exodus of top talent in the financial sector and further dent an already fragile economy. And since the financial crisis began in 2008, the divide between Britain and the EU has only grown wider and wider.

Officials are attempting to turn the page on the sovereign crisis the EU has been embroiled in for the past 3 years, and which has been eating away banking profits and confidence in the wider European banking sector.

Limiting bankers' bonuses might be welcome outside the UK, as it demonstrates that the EU are committed to overhauling the banking sector to safeguard against future crises.

But that view is not popular with the Britain's government or its banks, two of which the government remains the majority stakeholder.

British bank officials aren't too concerned about an integrated and policed European-wide banking sector --especially not as concerned as their colleagues on the continent. No, banks and politicians here are more concerned about de-leveraging themselves from the scandals that have led to a widespread distrust of the financial sector.

In order to repair this trust, UK policymakers and bankers would rather implement harsher regulatory measures such as the Vickers Plan, designed to keep saver and business deposits from being compromised by the more speculative activities typically undertaken by investment banking operations. To do this, Britain's bank managers are attempting to draw a line under the scandals by reviewing strategies, ring-fencing their operations and disposing or unwinding of assets deemed as risky and loss-making.

At no point have banks strongly considered the idea of capping bonuses; even the prospect of such measures irritates City banking officials.

But even if the bonus-capping proposals don't end up etched in stone, the rift between the UK and its European neighbors will continue to grow -- especially if David Cameron's offer of a nationwide referendum on Britiain's membership in the EU materializes.

So would limiting bank bonuses really prompt a mass exodus out of the City? Probably not, but it's hard to measure. What is more likely is that companies that do not need to have an EU-based business will invest elsewhere. The allure of the EU could even fade; the sovereign crisis shows no signs of abating and the EU itself may not be the powerhouse it once was, losing its charm with the UK and other nations as a result.

Pay packages for City bankers probably won't take a hit, but compensation will be shifted away from bonuses and towards bigger base salaries.

During the financial crisis of 2008, banks still paid bonuses despite being bailed out and losing money -- in fact, salaries in many cases were either raised or at least maintained. It is likely the reaction this time will be the same -- compensation will rise, but banks in the mid-to-long term won't need to have to pay big basic salaries and slowly businesses that don't need to be in the EU will cease to be. These proposals by the EU could force companies to move their headquarters elsewhere as the EU's attraction diminishes and London rental rates continue to aggressively climb.

More concerning is that these proposals by the EU do not grapple with the underlying issues that are affecting the UK banking system. This will not remove the specter of bailouts as compensations will be the same but dressed up slightly differently. These proposals do not address the "too big to fail" criticisms, nor do they address the lack of capital in banks.

While it's unclear how badly this new legislation will effect Britain, one thing is beyond dispute: capping bankers' bonuses certainly isn't going to have the world's brightest financial minds rushing into London.